An Objective Approach to Value

 Buying with an objective eye when purchasing income property is essential. You cannot afford to fall in love with a property if it does not benefit you after you buy it. Always use a financial analysis on the property to determine whether you can afford to own the property you are interested in.  

The one method of analysis income property is to utilize a Gross Operating Income Statement.  This is a statement that will help determine a property’s net income after all expenses are paid.  If the property you are analyzing does not generate enough net income to pay the mortgage payments and generate some extra available cash flow than you should not buy it.

Be realistic when structuring and analyzing any debt.  Develop a debt service structure that can be satisfied by the property’s cash flow.  Determine a monthly mortgage payments with an amortization calculator or mortgage factor chart. Remember if the net operating  income does not cover the total debt service than you have a negative cash flow.  Negative cash flow means you will have to come up with the extra cash out of your pocket.  If this is the case, than you  must ask yourself as an investor  ”is it worth it” for me or more importantly, can I afford to supplement the investment each month  until  the property produces an income.

By taking a hard look at the gross operating income  statement and analyzing the property to see if it can service the debt, you can buy according to your individual needs and assets and know objectively if you can afford it!

What the FHA Appraiser is looking for

The goal of all prospective properties is to meet or exceed the FHA Minimum Requirements to be eligible to qualify for the FHA residential mortgage.  It is the job of the appraiser to inspect the subject property for any possible defective conditions.  Defective conditions are deemed unacceptable and are not eligible until the defects or conditions have been the remedied and the probability of further damage is eliminated. 

Defective conditions include poor workmanship, defective construction, and evidence of continued foundation settlement, excessive dampness, leakage, rot, decay or termites and any other readily observable condition that impairs the safety, sanitation or structural soundness of the dwelling.

Major components of the dwelling that are inspected include roof, heating and air, siding, structure, electrical, plumbing and foundation.

The roof structure should be sound with no sagging or irregularities. There should be no missing shingles and no evidence of leaking.  Attic spaces must have proper ventilation.

The heating and cooling unit should operate correctly and have no loud sounds or unusual doers.  Lights should turn on and off normally.  There should be no electrical wiring exposed at any time.  All plumbing fixtures must operate normally with no observable signs of leakage.  Any “operable element” that has reached the end of its useful life within two years should be replaced.  

There should be no holes or damage to the siding, structure or interior walls.  There should be no wood frame or siding touching the ground.  There should be no evidence of termites.  Homes built before 1978 should have all defective paint scraped and repainted.  There should be no broken windows, doors and steps, steps without handrails, and blocked doorways.

The foundation should not have significant cracking or any pooling of water near the foundation.   Proper water drainage away from the foundation is essential.  Homes with crawl spaces must meet a minimum requirement of 18” and should be free of debris, dampness and mold. 

The final required repairs are all repairs necessary to preserve the continued marketability of the property and to protect the health and safety of the occupant.  Repairs costs are estimated and the work must be performed before the loan can close.

There are other site and external requirements exist that can disqualify a property, but in most cases if the home is located a typical residential area, than the eligibility lies within the subject dwelling which in most cases can be repaired to meet or exceed FHA Minimum Requirements.

1031 Exchange Properties

Any Real Estate property owner or investor of Real Estate may now wish to consider an exchange when he/she expects to acquire a replacement property following the sale of their existing investment property.  An exchange of “like properties” enables the owner to defer or avoid all of the capital gain tax due upon the sale of the original property, currently at 15%

A 1031 Exchange, also known as a tax deferred exchange is a method for selling one property, that’s qualified, and then proceeding with an acquisition of another property (also qualified) within a specific time frame.

The process of selling a property and then buying another property is a generally considered a standardized sale and buying situation.  The “1031 exchange” is unique because the transaction is treated as an exchange and not just as a simple sale. It is this difference between “exchanging” and not simply buying and selling which, allows the taxpayer(s) to qualify for a deferred gain treatment. Basically, sales are taxable with the IRS and 1031 exchanges are not. US CODE: Title 26, §1031. Exchange of Property

The IRS code is clear that a Qualified Intermediary must be chosen and act as independent organization whose only contact with the exchanger is to serve as an intermediary for the transaction. The Internal Revenue (IRS) Code requires that the person or entity serving as (QI) cannot be someone with whom the exchanger has had a former business or family relationship prior to the transaction. A Qualified Intermediary is a neutral but essential third party that prepares the 1031 exchange documents. When selecting a QI you should make sure they are bonded and insured. Fees for this type of transaction may range anywhere from $750 – $2000 to do an exchange.  Most CPA’s and Attorney’s specializing in Real Estate or Taxes can also perform this service.

Although the 1031 exchange of the IRS code offers an excellent opportunity for Real Estate investors by means of deferred tax exchange, investors also needs to be careful as there are a number of things that if included as a part of the exchange, that can still trigger a capital gain tax bill.

The real estate property you purchase should have a mortgage debt equal to, or greater than the property you are selling. In the rare case that the real estate property you buy has a lesser mortgage debt amount than the property sold, the difference in the mortgage value will be taxable to you.

In this situation that the seller of the property refinanced the property and you happen to assume the new higher debt. You are allowed to finance it through a new loan or you can add cash to the deal and the added cash offsets the debt relief on the property sold by you.

If the seller is paying cash for any repair charges that are required by the buyer then the amount paid by the seller towards the repair charges are considered as a cash excess and would also be taxable.

Investment property and personal residence property are not considered “like kind” property. So if you are buying a four family unit as part of a 1031 exchange, and then use one of the units as your personal residence, then 1/4 of the property would be considered as a 1031 exchange excess and you will have to pay taxes on that.

Often an investment property includes appliances such as stoves, washers & dryers, refrigerators etc. If these items are included in the sale you can end up paying capital gain taxes for these appliances. Appliances are not considered “like kind” property.

There may be other situations and conditions that apply. Such as extended time frames, damaged properties or other types of “unlike kind” property criteria. Investors should always perform their due diligence and consult with their accountant and attorney to discuss both the benefits and possible tax liabilities involved.*

* The information presented in this article is meant to inform and is not intended to give legal or tax advice.

Loan money for Fixer- Uppers

 

Purchasing a house that needs repairs is often a catch-22 situation. This is because the bank won’t lend you the money to buy the house until repairs are made and the repairs can’t be done until you have purchased the house.

A new HUD’s 203(k) program is available that can help you with this dilemma and allow you to purchase or refinance a property and include the cost of making the repairs and improvements in the loan. The FHA insured 203(k) loan is provided through approved mortgage lenders nationwide.

The down payment requirement for a purchaser is about 3.5% of the total acquisition including the repair costs.

The potential homebuyer locates a fixer-upper and executes a sales contract after doing
an analysis of the property with their real estate professional. The contract should
state that the buyer is seeking a 203(k) loan and that the contract is subject to a loan
approval based on the required repairs.

The homebuyer then selects an FHA-approved 203(k) lender and includes a detailed cost estimate on each repair or improvement.  An appraisal is then performed to determine the value of the property after the renovation.

If the borrower passes the lender’s credit-worthiness test, the loan closes for an amount that will cover the purchase or refinance cost of the property, the remodeling costs and the closing costs. The amount of the loan will also include a reserve of 10% to 20% of the total remodeling costs.

At closing, the seller of the property is paid off and the remaining funds are put in an escrow account to pay for the repairs and improvements during the rehabilitation period. Escrowed funds are released to the contractor during construction through a series of “draws” for completed work.

To find approved 203k lenders in your area go to 203k lenders search. To find out more about this type of loan go to

203K Rehab LoanInsuran- HUD

Things your Insurance May Not cover

There will always be gaps in home owner’s insurance coverage that you can’t do anything about.  Insurers aren’t going to cover you for a nuclear accident, for example, no matter how many companies you ask.

  “Exclusions” in coverage vary by the insurer, but if when something goes wrong, it may be way too late to begin learning about your policy.

If you know about some of them in advance, you may be able to switch carriers or buy extra insurance to stay protected.

Mold and water damage

When Ed Mc Mahon won a 7.5 million dollar lawsuit against his insurer over mold that he said sickened his family, a huge increase in mold-related claims occurred and which led insurers to eliminate or at least reduce their exposure.  Many insurers also limit how much they’ll cover for water damage.

In some cases, you may have trouble getting coverage for a home that’s had water claims in the past.

 

Sewer backup

Sewage backups are frequently not covered by home owner’s policies unless you purchase a special rider.

 Many homeowners who experience this particular disaster try to get their cities to pay for the damage, but governments typically aren’t liable unless the homeowner can prove negligence — and is willing to go to court over the matter.

A cheaper solution?  Buy the rider for $50 to $100 if you are not covered.

 

Neglect

Insurance generally covers sudden and unexpected losses such as damage from a falling tree but not losses from termites rodent infestation or a plumbing leak that never got fixed.  Insurers expect you to take care of any problems in the home and prevent any damage from getting out of control.  If it does, you may not be covered.

Bruce Johnson, author of "50 Simple Ways to Save Your House," recommends you conduct regular inspections of the exterior and look for cracks, decay or water damage.  Also check the condition of the roof,  the basement or crawl space for possible hidden problems.  Home maintenance problems left unchecked only get more expensive over time.

To learn more about other items that may be excluded from your policy, read the article, 10 Things your Insurance May Not Cover.

 

Energy Efficient Mortgages

In order to promote energy efficiency, HUD is proposing an Energy Efficient Mortgage product for homeowners which could provide incentives to those that invest in clean energy improvements.

HUD is also encouraging all federally-assisted housing agencies to go green. Through $250 million from the Recovery Act and $600 million in Capital Fund competitive grants, agencies are able to increase energy efficiency in their properties which will save money, protect the environment, and create jobs.

The  President’s announcement  to award 100 grants totaling $3.4 billion to private companies, utilities, cities, and other partners to help build a nationwide smart energy grid. As part of the American Recovery and Reinvestment Act, Baltimore Gas and Electric (BGE) in Baltimore, MD will receive $200 million to install two-million residential and commercial smart meters. These meters will reduce peak electricity usage by as much as one-third and save customers approximately $2.6 billion.

The Smart Grid will allow consumers to have real-time information on the costs of their energy use, and the ability to manage their energy consumption and save money

 

Is there an increased trend in owner financing?

It is no surprise that the banks have tightened their lending requirements. This has caused a situation of an increasing amount of people wanting to purchase a home but unable to secure a mortgage through conventional financing.

 

There are a lot of potential buyers that may be too risky for a bank to extend a loan due to for example, a prior bankruptcy in the past. However, many of these buyers have steady work histories, make good money and may be an acceptable credit risk for homeowners. Prospective buyers may be unable to get an affordable rate and may be a trusted friend or family member.

Also, there are not as many owners willing to finance which means less competition for the seller. Less competition means there is more opportunity to sell the home closer to the higher end of the market value.

Selling a real estate asset through owner finance can net a better return over the long term than putting the same amount of money in a bank and earning interest from it.

 

A person selling a home through owner financing arrangement essentially is in the position of the bank. So if the buyer fails to abide by the terms of the owner finance agreement, the owner will have to take action. However, agreements can be designed to protect the seller and minimize the potential of loss or foreclosure. Working with an attorney in drafting an owner finance agreement is essential.

 

Although sellers ultimately determine if owner financing is the right option for them, there is an increased desire and trend for properties sold with owner or private financing and some sellers may find it advantageous to cater to that trend.

 

How much Equity do I need?

Fannie and Freddie require just 5% equity in your home but more if it is a secondary home or investment property.

If the have less than 20% equity, you must get PMI insurance(PMI protect the lender if you default).

With FHA you can refinance with only 2.25% equity.  The agency provides its own PMI and there are both upfront fee

and monthly premium. FHA doesn’t impose a credit score threshold, but some FHA lenders require about a

minimum of 580 to 620.

Fannie and Freddie generally set the limit for mortgage loan payments at 36% of your monthly pretax income

unless you can prove that you can handle more. FHA generally sets its limit at 31%.

Stop those leaks

 

On average a home is reported to drip drip drip away about 11,000 gallons of water a year. Going green is about saving energy and natural resources.

Here are my best picks saving money{on the water bill}, natural resources and even help protect the other major components of your home from further wear and tear.

• Indoor Faucets – Replace rubber washers beneath knobs.

• Outdoor Spigot – Unscrew handle to replace rubber washers and tighten connecting hose nut.

• Toilet – Flappers inside the tanks are notoriously to blame for leaks in the commode- flush value seats (the place that the flapper sits on) should have a tight seal.

• Showerheads- Unscrew the shower head. Wrap the supply pipe with Teflon tape and reattach.

The Energy Efficient Home

A newly constructed dwelling may be considered by lenders as energy efficient if it is built in compliance with qualifying energy conservation programs like that of the National Association of Home Builders (NAHB). NAHB programs meet the classification for thermal performance guidelines or if the building meets standards of the Council of American Building Officials 1992 Model Energy Code.

 

When inspecting a property the appraiser includes an evaluation of any and all energy efficient characteristics of a property and give an overall rating of “Adequate”,” Low” or “High” in the applicable section of the form. The lender may take the energy savings into consideration when evaluating the borrower’s debt to income ratio if the property receives a “High” rating.

A dwelling must include features from each of the three major categories, those being Insulation, Windows & Doors and Heating & Cooling Systems.